The Deficient Markets Hypothesis
Most intelligent observers now reject the hypothesis that the prices on the political betting/prediction markets reflect all of the available public and private information. Moreover, they know that so-called rational traders do not always arbitrage away mispricing, but rather, in fact, quite often go out of their way to encourage it. Overconfident traders with big bank balances are able to boss the betting market price action over extended periods of time and they are able to benefit from intimidating informed traders out of their own private positions. In nuce, all of the traders in political betting markets are imperfectly rational - trapped inside a Foucauldian nightmare of their own making. Those that have the most influence over the organisation of the betting market (the whales) have power over both the nature of social interaction taking place within the betting market and subjective experiences more generally. What is it that they know? - That most people, regardless of their pre-existing prior beliefs actually anchor down around the probability estimate that they are presented with (few actually ever seek to act on their own private information through trading away from the quotes on offer). That most people simply overestimate the ability of prediction markets to incorporate public and private information and happily buy into the notion that the prices on offer fully reflect all of the available information. They Don't!
When confronted with dissonance between the current betting market price and their own subjective probability, most traders, perhaps blinded by the notion of the wisdom of crowds, typically assume that it is their probability assessment that must be wrong. We conjecture that in these circumstances traders rather than agreeing to disagree with the betting market, typically move to disregard their own priors and conclude that other people must know something that they don't. Accordingly, in most instances, they choose to trade at the price on offer as though it had been enshrined within it some sort of objective truth.
| Outcome | Implied Probability |
|---|---|
| Trump | 44% |
| Biden | 56% |
Source: Betfair. 27/02/2023.
In the face of excess betting market price volatility, the notion that the betting market price represents the perfect signal is refuted every time that the price moves.
Nonetheless, people are more that happy to delude themselves that the price that they have traded at must have somehow represented the perfect price. For example, the S&P 500 and the Nasdaq retreated on Wednesday September 23 2020 as data showed that domestic business activity had nudged down in September, suggesting a loss of momentum in the economy as the third quarter draws to a close. And what happened to Trump's odds on Betfair - why, he shortened into 2.20 from 2.26. Trump's only hope of actually winning the election is if there were to be a stable economic rebound. These economic numbers came on the heels of ABC/Post polls that showed strong results for Biden in Minnesota and Wisconsin - two of the eight key states in the election. What price activity there was on the day was very clearly driven by the decision of a whale to shorten Trump's odds - and people responding to that price action.
Prices reflect the beliefs of those operating in the betting market at a particular moment in time – nothing more and nothing less. No one that is trading in these betting markets is immune from biases. Recent theoretical work in developmental psychology suggests that humans are predisposed to align their mental states with those of other individuals. The propensity in the betting markets to herd and to respond to information cascades ensures that most people are simply discounting their own private beliefs and trading on the back of somebody elses information. That is why significant mispricings can and do occur and why they can stay in place over extended periods of time - right up until the betting market on a particular event terminates (per Trump 2016 election and Brexit prediction markets).
To cite this article: Niall O'Connor The Deficient Markets Hypothesis
(Published on Bettingmarket.com 24/09/2020 . All Rights Reserved.)